International Business; Talk of a Bubble as Venture Capitalists Flock to China

By GARY RIVLIN

Published: December 6, 2004

LATELY, a joke has been making the rounds among Silicon Valley venture capitalists: these days, you're far more likely to run into a colleague at a hotel bar in Beijing or Shanghai than at a local haunt in Northern California.

The joke has the ring of truth. These days, venture investors say, it is hardly possible to step into the business-class cabin of a flight from San Francisco to China without running into at least a couple of competitors.

Gerard H. Langeler, a partner in the Portland, Ore., office of the OVP venture partnership, confesses that he is frightened when he contemplates all those trips to China. ''It's a scary thing because you worry the bubble phenomenon is moving five years later to a different locale,'' he said.

Venture capitalists are focusing on China partly because they are sitting on more money than they could possibly invest in American-based start-ups. Collectively, venture firms in the United States have on hand $64 billion, according to the research firm VentureOne, yet they are investing only about $5 billion a quarter.

Investors, who are focusing on semiconductor, telecommunications and Internet start-ups, also want to tap China's potential to provide outsourcing services to the companies already in their portfolios.

But mainly, venture capitalists are hauling themselves across 16 time zones because of successes like 51job Inc. The company, a Shanghai-based provider of integrated human resource services in China, went public on the Nasdaq on Sept. 30.

Doll Capital Management, based in Menlo Park, Calif., invested $14 million in 51job in early 2000. Today that investment is worth more than $260 million and represents the largest return in the firm's history, said David Chao, a Doll Capital founding partner.

Doll Capital was among the first American-based venture firms to invest in China-based start-ups. ''Statistically speaking, it's still better to invest in the U.S., no question,'' said Mr. Chao, who figures that he travels to China an average of every six weeks. ''But if you have access to good deal flow in China, and if you have the right experience, the rewards are large.''

At the same time, many unhappy endings may lie ahead. Mr. Chao wonders whether the newcomers will demonstrate patience -- a trait not normally associated with venture capitalists -- or impetuously pursue the next 51job. In the process, they may learn the hard way that China is a very different from anywhere else on earth as a place to do business.

''I think of China as the wild, wild West,'' said Mr. Chao, an ethnic Chinese who was reared in Japan. ''Business law has only been in practice for the last 10 years. There are all these fundamental issues that have yet to be resolved. What rights does a shareholder have in China? There's also this significant cultural gap.''

Mr. Chao is convinced that in time, many venture capitalists will wish they had remained closer to home. ''There's definitely a bit of a lemming effect going on here,'' he said. ''A lot of these guys will end up getting burned.''

Jing Huang, managing director of the Softbank Asia Infrastructure fund, is inclined to agree. Mr. Huang was born and reared in China, and earned his B.A. in Beijing. He earned an M.A. from Stanford University and an M.B.A. from Harvard.

He distinguishes between venture capitalists like himself who are based in China, though they are investing foreign dollars, and those he calls the ''traveling V.C.'s,'' whose offices are thousands of miles away. (A third category, the local venture capitalist investing local money, is almost nonexistent, Mr. Huang and others said.)

''You can hear the difference between the two groups,'' Mr. Huang said. ''The traveling V.C. whose interest is only recent sees the positive side of things a lot more than we do. They tend to underestimate some of the difficulties of doing business here. They look at Nasdaq and see 51job and decide they should invest.''

The traveling venture capitalist is also inclined to pay American prices for an ownership stake in a Chinese start-up, despite the difficulties of doing business in a country where intellectual property laws are still a work in progress, where private banks are still rare and where regulatory requirements are far more onerous than in the United States.

''In recent months, we've needed to walk away from some deals because the traveling V.C.'s are getting involved, and they are willing to pay too much,'' Mr. Huang said. That is especially true, he added, when a start-up is led by a Chinese national who has spent time in the United States.

''They know how to do a very good presentation for the traveling V.C.'s,'' Mr. Huang said.

Not everyone is inclined to think the worst of the new jet-setting investors. Chang Sun, a venture capitalist at Warburg Pincus Asia in Hong Kong and founder of the China Venture Capital Association, said that most of the venture capitalists who have recently discovered China are ''sort of window-shopping -- people are still mainly looking and talking.'' Unlike Mr. Huang, who is based in Beijing, Mr. Sun, who is based in Hong Kong, has not seen a spike in the price that venture capitalists apply to local start-ups.

''Chinese companies are holding out for higher valuations,'' Mr. Sun said, ''but so far we're not seeing actual deals done in such a way that we're seeing inflated, crazy prices. Not yet at least.''